The advent of computerized trading (interchangeably known as electronic trading) and low latency and other algorithmic trading rely upon sophisticated computer programs to handle large volumes of orders to one or more exchanges in times far too short for humans to accomplish, follow or directly manage. At these speeds, there is significant risk that a programming fault can cause a significant volume of trades to occur before any human could recognize a problem exists and rectify it thereby increasing the risk to the trading entity and of an adverse affect on the market as a whole.
This can easily be illustrated in a simplified example, involving a single stock. Assume that an entity initiates an order (buy or sell) of 1000 shares of XYZ stock. With current trading platforms that order can be handled in several ways. It may be routed to a single market for execution as a block or, using “order slicing” it can be broken up into smaller “slices” (for example: (1) 10 orders of 100 shares each, (2) one order of 500 shares, one order of 200 shares and 3 orders of 100 shares each, two orders of 500 shares, (3) five orders of 200 shares, etc.) to either a single market or two or more different markets, at the same time or on staggered timing, for execution. In some cases, the order may even be broken down into multiple “odd lots” (i.e. lots of less than 100 shares), which do not appear in the publicly available “consolidated data” reporting.
However, a problem can arise if some component of the routing software, or a hardware problem, causes that order (or some part thereof) to improperly, repeatedly issue in rapid-fire fashion. In such a case, what was intended as a single order of 1000 shares of XYZ could, in an instant, become a series of orders for many, many more shares than intended, likely quickly and erroneously affecting the price of XYZ stock.
While the erroneous multiplication of a single order a few times may not result in a significant loss or market disruption, it can easily be seen that issue may be dramatically magnified in a matter of seconds if the problem affects multiple stocks and/or markets, and can cause significant disruptions to not only the involved stocks, but also have a cascading effect on related options and indices, and in some cases, the markets themselves.
This is a very real problem because it is not unusual for order flow to result in more than thousands or even tens of thousands of trades per second on any one of multiple exchanges, far quicker than any human could comprehend let alone promptly react to if a problem arose. For example, as reported in a Knight Capital Group, Inc. (“Knight Capital”) press release, in August 2012, Knight Capital experienced a technology issue in its automated trading system's trading software that resulted in Knight sending numerous erroneous securities orders into the market. When finally recognized, the erroneous orders had to be traded out of, and consequently caused a loss of over $400 million.